MONTPELIER, Vt.-Soft market or not, Vermont continues to attract its fair share of new captives.

Still, state officials and those in the industry are looking for new ways to sharpen Vermont's competitive advantages.

A key provision of a legislative package under consideration this spring would allow single-parent captives to write "controlled unaffiliated" business.

This regulatory change could attract new captives to the state and allow greater use of some existing ones, enabling risk managers whose companies are increasingly reliant on outsourcing to use their Vermont captive programs to address new risks.

Meanwhile, considerable activity by banks to form Vermont captives to write credit life and mortgage insurance is raising hopes that financial institution captives might be a boom market for Vermont in the year ahead.

Thirty new captives formed in Vermont in 1996, with seven dissolving, bringing the total at year's end to 293, a net gain of 23 from 1995. That increase was a sizable jump from the net gain of six the state racked up in 1995 when 17 new licenses were issued and 11 captives dissolved.

"This is the irreducible minimum, I think, 20 to 30 a year regardless of hard market or soft," said George A. Chaffee, president of Skandia International Risk Management (Vermont) Inc. in Burlington. "People find plenty of good reasons to form captives," he added.

The growth trend appears likely to continue this year, according to Leonard D. Crouse, Vermont's director of captive insurance. Through February the state had added five new captives, and had three applications pending.

"They're large corporations. Two of them are Fortune 500 companies," Mr. Crouse said. "Regardless of what people say, not every Fortune 500 company has a captive yet," he said.

"The captive formations are continuing despite the market conditions," he said.

Premium volume continued to grow in 1996 as well, increasing nearly 5.5% to $2.89 billion last year.

Adding 10 captives last year, which brought its captive roster to 72 at the end of 1996, J&H managed captives wrote $661.6 million in premium last year, with M&M's 38 Vermont-managed captives writing $633.4 million in gross premiums.

"We had a phenomenal year. A lot of new business, expanding business from our existing clients," said Julie S. Boucher, vp at J&H in Burlington. "We grew a lot, but it was manageable growth," she said.

As a result of the growth, J&H added five people to its Vermont staff last year, bringing the total to 37, and had planned to add four more staffers this year. "And that's pretty significant for us or anybody," Ms. Boucher said.

M&M also was growing, adding five captives last year, two new ones so far this year "and we've got quite a few in the pipeline, and I think that's true of the industry," said Raymond C. Oberg, senior vp at M&M in Burlington.

Also in the process of adding staff, M&M already had plans to move to new offices in Burlington later this year before the merger with J&H was announced. In the wake of the merger, though, the two big captive managers are evaluating their future office plans and operations.

Rounding out the top five managers in Vermont last year were:

American Risk Management Corp. with 38 captives writing $428.1 million in premiums.

Yankee Captive Management Inc. with four captives writing $273.7 million in premiums.

Alexander Insurance Managers with 36 captives under management writing $257.8 million in premiums.

"I think being an independent has some advantages," said Andrew Sargeant, president of Vermont Insurance Management Inc. in Montpelier. An independent view might be sought when a captive owner has several broker relationships, for example.

Mr. Sargeant came to VIM from Sedgwick Management Services in 1995 when Sedgwick struck a deal with VIM and its USA Risk Group partner companies to manage Sedgwick's U.S.-domiciled captives.

"You never know, if Sedgwick was to merge with somebody it may work out to our benefit," Mr. Sargeant said, adding such a merger might bring in business.

Nancy Gray, a vp at ARM in Burlington, agreed that the mergers of the large brokers could be good news for independent captive managers.

"I think ultimately the mergers will be very beneficial to us," she said. "There are fewer managers to choose from now and that might be good for the independents."

But Peter A. Joy, president of ARM, suggested the merger and partnering activity could prompt some industry changes.

"The Sedgwick and VIM agreement, the Aon acquisition of A&A, and the pending purchase of Minet and now J&H by M&M are really limiting the choices of the captive owner in selecting a captive manager capable of offering an independent analysis of the overall captive program and the performance of the associated service providers," Mr. Joy said.

That could make things tougher for the smaller independents though, he said.

"Those small independent managers without an international presence and an understanding of the market outside of just their management capabilities will find it increasingly difficult to compete for quality clients," Mr. Joy said.

Roger D. Teese, president and CEO of SB&T Captive Management Co. in Burlington, said activity from the large "alphabet house" brokerages is already making it tough for independent companies like his.

SB&T lost the University of Michigan captive, Veritas Insurance Co., to A&A this year, "but the University of Michigan had A&A as its broker for a long time," he said. "I guess it was a matter of time. We had them for 10 years."

While he wasn't certain what sort of fallout might develop from deals like the Aon-A&A and M&M-J&H mergers, he allowed that it might provide independents some new opportunities.

"When we've been able to have an apples for apples comparison for the clients, we come out ahead," Mr. Teese said. "For one thing we can compete on price. Our overhead is lower. We appeal to stronger risk managers who know what they want to do."

The leap one independent manager-Yankee Captive Management-made up the Vermont rankings to fourth last year from the ninth spot in 1995 was largely the result of the addition of Attorneys' Liability Assurance Society Inc., A Risk Retention Group, which redomesticated to Vermont from Illinois last year, bringing $234.3 million in premium with it. ALAS is by far Vermont's largest group captive.

Missing from the top five was Vermont Insurance Management, however, which fell from the fifth spot in 1995 to ninth last year. The manager's Vermont captive count dropped to 25 last year from 29 the prior year, with premium volume following suit, dropping to $115.8 million in 1996 from $211.2 million in 1995.

The departure of VIM's president, Michael T. Rogers, led to some clients moving their business to other captive managers.

One of those moves was Professional Consultants Insurance Co., which wrote nearly $10.7 million in premium last year. It left Vermont Insurance Management for Skandia last October.

Great prospects for captive growth in Vermont are captives formed to write mortgage and credit-life coverage.

"We licensed our first mortgage insurance company in 1995 and we licensed three in '96," Mr. Crouse said. "This is really quite active. There are a number of banks out there that are now looking at forming these insurance companies."

From a regulatory perspective, Mr. Crouse noted that any bank setting up a mortgage insurance company will have to be examined by the federal Office of the Comptroller of Currency and, while non-bank mortgage lenders are not required to go through the OCC, "We're going to do mortgage companies by the rule and regulation of the OCC."

"It's like you have two people looking at them, us and the OCC, so you feel comfortable with that," Mr. Crouse said.

"All these mortgage insurers are monoline insurers," the captive division head said. "We've had some banks ask us if they could use their existing captives and we told them, 'No, you have to set up a separate one.' "

In the credit-life area, a more favorable regulatory environment seems to be leading Vermont to draw captives previously located in Arizona.

"Vermont will allow a multiline captive for credit life. Arizona won't," M&M's Mr. Oberg said. That could be particularly significant in the face of Clinton administration proposals to cut tax advantages for captives that fail to meet a 50% third-party business threshold.

"It's a profit play for financial institutions," Mr. Oberg said. "With the Clinton proposal, at least that industry has a practical solution to a potential problem if they write enough credit life," Mr. Oberg said.

"The reduced costs, more enlightened regulation and greater flexibility in adding new lines of business and lack of investment restrictions are causing many Arizona-based captives to relocate to Vermont," ARM's Mr. Joy said. "We are actively working on five and have two more in the pipeline."

He added that his firm also expects to have two mortgage insurance captives active in the next few months.

Mr. Teese said he believes a firm like his can capitalize on the captive opportunities emerging in the banking area.

"Sometimes there are tax advantages for smaller banks that could encourage them to get involved," Mr. Teese said. "And they're all looking at how to get involved in insurance and this is a way they could do it fairly painlessly."

"I think we will have opportunity there because a lot of the banks are insured through small to midsize agencies, and they'll want to keep that business there," he said. "Vermont can now do credit life and mortgage insurance and a small bank can still do that."

"The alphabet house, of course is going to figure it out and the independent agency isn't going to figure it out as soon," Mr. Teese said. "So we're going to help them, bring it to their attention."

"There's that opportunity now to make captives make sense for even small banks in Vermont," said Gary Osborne, a senior vp with USA Risk Group in Montpelier. "We're seeing quite a lot of interest on that front. It's a profit opportunity rather than just a cost saving opportunity."

Mr. Joy suggested larger banks enjoy some advantages in establishing mortgage insurance captives but that there may be ways for smaller institutions to clear any hurdles.

"You have to have a willing fronting carrier," he said. "And obviously the leverage the big banks can bring in premium volume goes a long way to getting a compliant fronting carrier."

The potential may prompt some local banks to come together to get that purchasing power, however.

For example, an association of Vermont banks to form a mortgage insurance captive might be a logical step, Mr. Joy said. "Several of them have spoken to me about whether I think a captive through their association would work."

Those in Vermont's captive industry also are excited about the legislative package that could expand business opportunities for Vermont captives.

The legislation would allow single-parent captives in Vermont to write controlled unaffiliated business, extend confidentiality protection to state files on captive companies and permit captive insurance companies to form as reciprocal insurers.

"What we're trying to do is basically stay abreast of the market, what companies are looking for, what they're looking to do," the captive division's Mr. Crouse said.

Under the legislation, the unaffiliated business would still have to be somehow connected to the captive sponsor's business, Mr. Crouse said. "One of our pure captives is not going to go out and do completely unrelated business."

Richard C. Heydinger, director of risk management services for Hallmark Cards Inc. in Kansas City, Mo., said the legislation illustrates the responsiveness of Vermont officials to the captive industry and captive owners.

He said he first met with legislators to discuss the issues last year. His company is particularly interested in the confidentiality and unrelated business provisions.

"For companies like Hallmark, confidentiality is darn important because we file real detailed business plans. That's how they regulate our captive up there," he said.

"When we went to the Legislature and said we need to support the department on confidentiality and say we don't want to allow anybody who wants to do Hallmark some harm or get access to details of our business they did it," the Hallmark risk manager said.

"It's very unfair for a large risk retention group, a large captive, whatever to put a lot of time into putting a program together and then somebody else comes in and just looks at the file and there you go," Mr. Crouse said.

As for the unrelated business provision, Vermont's captive insurance provisions must keep pace with changes in the way corporations do business, Mr. Heydinger said.

"The stuff they used to call 'related unrelated,' that's the sort of stuff we're interested in because we rely more and more on our vendors and our distributors," he said. "Business models shift and the shift that's going on now is outsourcing.

"What that means is we're relying on a lot more unrelated but very strategic partners. They're very critical to us," Mr. Heydinger said. "We need to help these people do the right things for us and for themselves as part of our risk management program."

Covering those partners through the captive would allow Hallmark to extend its loss control programs to them, thus reducing Hallmark's exposure to losses stemming from problems the partners might suffer.

Essentially, the confidentiality provision would codify a position the captive division has already been taking, M&M's Mr. Oberg said. "Pure captives have a lot of proprietary information they don't want competitors to know about."

Mr. Oberg said he was wary of any unrelated business legislation curtailing flexibility by setting specific limits on such business. The measure passed from the Vermont House to the Senate in late March left the limit at the discretion of the captive division, however, which Mr. Heydinger said he thinks is the right approach.

"I think Vermont is ready for it now," SB&T's Mr. Teese said of the third-party business provision. "There's enough experience at the state level to regulate it and there's enough experience and expertise at the management companies to support it."